| This study explores the role of the third moment of the probability distribution of rates of return in portfolio selection.;The third moment is particularly relevant to highly skewed assets such as option contracts and lotteries, as well as to behavior that can be approximated by maximizing expected cubic utility. Hence, elementary prospects are studied and the cubic utility function analyzed in depth. The framework developed is consistent with the Friedman-Savage approach to expected utility models.;The study goes on to investigate implications of maximizing expected cubic utility for liquidity preference, the choice of risky assets, and the valuation of option contracts. An empirical investigation of call options' data suggests that skewness may be playing a specific role in pricing of such contracts.;The theoretical analysis begins with definitions of skewness preference functions that serve as complements to the well known risk aversion measures. |
